With government deficits we are leaving our debt burden to our children.
Fact:
Collectively, in real terms, there is no such burden possible.
Debt or no debt, our children get to consume whatever they can produce.
This deadly innocent fraud is often the first answer most give to what they perceive to be the main problem associated with government deficit spending.
Borrowing now means paying for today’s spending later.
Or, as commonly seen and heard in the media:
“Higher deficits today mean higher taxes tomorrow.”
And paying later means somehow our children’s real standard of living and general well being will be lower because of our deficits.
Professional economists call this the ‘intergenerational’ debt issue. It is thought that if the federal government deficit spends, it is somehow leaving the real burden of today’s expenditures to somehow be paid for by future generations.
And the numbers are staggering.
But, fortunately, like all of the 7 deadly innocent frauds, it is all readily dismissed in a way that all can understand.
In fact, the idea of our children being somehow necessarily deprived of real goods and services in the future because of what’s called the national debt is nothing less than ridiculous.
A year or two ago I ran into former Senator and Governor Lowell Weicker of Connecticut and his wife Claudia on a boat dock in St. Croix. I asked Senator Weicker what was wrong with the country’s fiscal policy. He replied we have to stop running up these deficits and leaving the burden of paying for today’s spending to our children.
I then asked him the following questions to hopefully illustrate the absurdity of his statement:
“When our children build 15 million cars per year 20 years from now, will they have to send them back in time to 2008 to pay off their debt?”
“Are we still sending real goods and services back in time to 1945 to pay off the lingering debt from World War II?”
Interestingly, it was Claudia who instantly grasped it, agreed with me, and asked her husband what he had to say to that. All he could say was he had to think about it some more.
Of course we all know we don’t send real goods and services back in time to pay off federal government deficits, and that our children won’t have to do that either.
Nor is there any reason government spending from previous years should prevent our children from going to work and producing all the goods and services they are capable of producing.
And in our children’s future, just like today, whoever is alive will be able to go to work and produce and consume their real output of goods and services, no matter how many US Treasury securities are outstanding.
There is no such thing as giving up current year output to the past, and sending it back in time to previous generations. Our children won’t and can’t pay us back for anything we leave them—even if they wanted to.
What the government deficits can influence is the current year distribution of real output.
Distribution is about who gets all the goods and services that are produced. In fact, this is what politicians do every time they pass legislation. They redirect real goods in services by decree, for better or for worse. And the odds of doing it for better are substantially decreased when they don’t understand the 7 deadly innocent frauds. Each year, for example, Congress discusses tax policy, always with an eye to the distribution of income and spending. Many seek to tax those ‘who can most afford it’ and direct federal spending to ‘those in need.’ And they also decide how to tax interest, capital gains, estates, etc. as well as how to tax income. All of these are distributional issues.
In addition, Congress decides who they hire and fire, who they buy things from, and who gets direct payments. Congress also makes laws that directly affect many other aspects of prices and incomes.
Foreigners who hold US dollars are particularly at risk. They earn those dollars from selling us real goods and services, yet have no assurance they will be able to buy real goods and services from us in the future. Prices could go up (inflation) and the US Government could legally impose all kinds of taxes on anything foreigners wish to buy from us, which reduces their spending power. Think of all those cars Japan sold to us for under $2,000 years ago. They’ve been holding those dollars, and would now probably have to pay in excess of $20,000 per car to buy cars from us, if they even wanted to. What can they do? Call the manager and complain? They’ve traded millions of perfectly good cars to us in exchange for credit balances on the Fed’s books that can buy only what we allow them to buy. And look at what happened recently- the Federal Reserve cut rates which reduced the interest Japan earns on its US Treasury securities. (This discussion continues in a subsequent innocent fraud.)
This is all perfectly legal and business as usual, as each year’s output is ‘divided up’ among the living. None of the real output gets ‘thrown away’ because of outstanding debt, no matter how large. Nor does outstanding debt necessarily reduce output and employment, except of course when ill informed policy makers decide to take anti deficit measures that do reduce output and employment. Unfortunately, that is currently the case, and that is why this is a deadly innocent fraud.
Today (December, 2009), it’s clear Congress is taking more spending power away from us in taxes than is needed to make room for their own spending. Even after we spend what we want and our government does all of its massive spending, there’s still a lot left unsold in that big department store called the economy.
How do we know that? Easy, count the bodies in the unemployment lines. Looks at the massive amount of excess capacity in the economy. Look at what the Fed calls the ‘output gap’ which is the difference between what we could produce at full employment and what we are now producing. It’s enormous.
Sure, there’s a ‘record deficit and national debt,’ though still far below Japan’s, most all of Europe, and WWII US deficits that got us out of that depression with no ‘debt burden consequences’ of course.
And if you’ve gotten this far into this book hopefully you know why the size of the deficit isn’t a financial issue. And hopefully you know that taxes function to regulate the economy, and not to raise revenue the way Congress thinks.
When I look at today’s economy it’s screaming at me that that problem is people don’t have enough money to spend. It’s not telling me they have too much spending power and are over spending.
Who would not agree?
Unemployment has doubled and GDP is more than 10% below where it would be if Congress wasn’t taking so much spending power away from us.
THAT IS THE EVIDENCE WE ARE OVER TAXED.
And when we operate at less than our potential- less than full employment- then we are depriving our children of the real goods and services we could be producing on their behalf. When we cut back on our support of higher education we are depriving our children of the knowledge they’ll need to be the very best they can be in their future days. When we cut back on basic research and space exploration we are depriving our children of all the fruits of that labor we are instead transferring to the unemployment lines.
So yes, those alive get to consume this year’s output, including the decision to use some of the output as ‘investment goods and services’ which serve to hopefully increase future output.
And yes, Congress has a big say in who consumes this year’s output. And potential distributional issues due to previous federal deficits can be readily addressed by Congress and distribution can be legally altered to their satisfaction.
So How Do We Pay Off China?
Those worried about paying off the national debt can’t possibly understand how it all works at the operational, nuts and bolts, debits and credits level. Otherwise they would realize that question is entirely inapplicable.
What they don’t understand is that both dollars and US Treasury debt (securities) are nothing more than ‘accounts’ which are nothing more than numbers that the government makes on its own books.
So let’s start by looking at how we got where we are today with China.
It all started when China wanted to sell things to us and we wanted to buy them.
For example, let’s suppose the US Army wanted to buy $1 billion worth of uniforms from China, and China wanted to sell $ billion worth of uniforms to the US Army at that price.
So the Army buys $1 billion worth of uniforms from China.
First, understand both parties are ‘happy.’ There is no ‘imbalance.’ China would rather have the $1 billion than the uniforms or they wouldn’t have sold them, and the US army would rather have the uniforms than the money or it wouldn’t have bought them. The transactions are all voluntary.
But back to our point- how does China get paid?
China has a ‘reserve account’ at the Federal Reserve Bank. A reserve account is nothing more than a fancy name for a checking account. It’s the Federal RESERVE Bank so they call it a RESERVE account instead of a checking account.
So to pay China, the Fed adds $1 billion to China’s checking account at the Fed. It does this by changing the numbers in China’s checking account up by $1 billion.
China then has some choices. It can do nothing and keep the $1 billion in its checking account at the Fed, or it can buy US Treasury securities.
A US Treasury security is, functionally, nothing more than a fancy name for a savings account at the Fed. The buyer gives the Fed money, and gets it back later with interest. That’s what a savings account is- you give bank money and you get it back later with interest.
So let’s say China buys a one year Treasury security.
All that happens is that the Fed subtracts $1 billion from China’s checking account at the Fed, and adds $1 billion to China’s savings account at the Fed.
And all that happens a year later when China’s one year Treasury bill comes due is the Fed takes that money out of China’s savings account at the Fed and puts it in China’s checking account at the Fed.
Right now China is holding some $2 trillion US Treasury securities. So what do we do when they mature and it’s time to pay China back? We move the money from their savings account at the Fed to their checking account at the Fed and wait for them to say what, if anything they might want to do next.
This is what happens when all US government debt comes due, which happens continuously. The Fed moves money from savings accounts to checking accounts on its books. And when people buy Treasury securities, the Fed moves money from their checking accounts to their savings accounts. So what’s all the fuss?
It’s all a tragic misunderstanding.
China knows we don’t need them for anything and is playing us for total fools. Today that includes Geithner, Clinton, Obama, Summers, and the rest of the administration. It also includes Congress and the media.
They know all we owe them to ‘pay them back’ is a bank statement from the Fed that says how much is in their checking account at the Fed.
Now let me describe this all a bit more technically for those of you who care.
When a Treasury bill, note, or bond is purchased by a bank, for example, the government makes two entries on its spreadsheet we call the ‘monetary system.’
First, it debits (subtracts from) the buyer’s reserve account (checking account) at the Fed.
Then it increases (credits) the buyer’s securities account (savings account) at the Fed.
As before, the government simply changes numbers on its own spread sheet - one number gets changed down and another gets changed up.
And when the dreaded day arrives, and the Treasury securities Chinas holds come due and need to be repaid, the Fed again simply changes two numbers on its own spread sheet.
The Fed debits (subtracts from) China’s securities account at the Fed.
And they credit (add to) China’s reserve (checking) account at the Fed.
That’s all- debt paid!
China now ‘has its money back.’ It has a (very large) dollar balance in its checking account at the Fed. If it wants anything else- cars, boats, real estate, other currencies- it has to buy them at market prices from a willing seller who wants dollar deposits in return. And if China does buy something the Fed will subtract that amount from China’s checking account and add that amount to the checking account of whoever China bought it all from.
Notice too, that ‘paying off China’ doesn’t change China’s stated $ wealth. They simply have dollars in a checking account rather than US Treasury securities of equal dollars. And if they want more Treasury securities instead, no problem, the Fed just moves their dollars from their checking account to their savings account again, by appropriately changing the numbers.
Paying off the entire US national debt is but a matter of subtracting the value of the maturing securities from one account at the Fed, and entering adding that valued to another account at the Fed. These transfers are non-events for the real economy, and not the source of dire stress presumed by the mainstream economists, the politicians, business people, and the media.
One more time:
To pay off the national debt the government changes two entries in its own spreadsheet - a number that says how many securities are owned by the private sector is changed down, and another number that says how many $ US are being kept at the Fed in reserve accounts is changed up.
Nothing more.
Debt paid, all creditors have their ‘money back’.
What’s the big deal?
So WHAT HAPPENS IF:
CHINA REFUSES TO BUY OUR DEBT AT CURRENT LOW INTEREST RATES PAID TO THEM. INTEREST RATES HAVE TO GO UP TO ATTRACT THEIR PURCHASE OF THE TREASURY SECURITIES, RIGHT?
Wrong! They can leave it in their checking account. It’s of no consequence to a US government that understands its own monetary system. The funds are not ‘used’ for spending, as we previously described. There are no NEGATIVE CONSEQUENCES OF THAT.
WHAT HAPPENS IF CHINA SAYS—I DON’T WANT TO KEEP A CHECKING ACCOUNT AT THE FED ANY MORE? PAY ME IN GOLD OR SOME OTHER MEANS OF EXCHANGE?
NOT POSSIBLE UNDER OUR CURRENT “FIAT CURRENCY” SYSTEM1
And some day it will be our children changing numbers on what will be their spread sheet, just as seamlessly as we did.
Though hopefully with a better understanding!
But for now, the deadly innocent fraud of leaving our debt to our children continues to drive policy, and keeps us from optimizing output and employment.
The lost output and depreciated human capital is a real price we and our children paying for now that diminishes both the present and the future. We make do with less than what we can produce, and sustain high levels of unemployment, while our children are deprived of the real investments that would have been made on their behalf if we knew how to keep our human resources fully employed and productive.
